Since 1982, the international debt situation has been a chief focus of the International Monetary Fund’s World Economic Outlook, as well as of the general economic surveys published by other institutions and of numerous books and articles by academic economists. Out of this bewildering mass of data and analyses, one central truth has clearly emerged: the world economy has been facing not only a “debt crisis” but also a “growth crisis,” and that these crises are closely interrelated. The growth crisis emerged initially as the result of the slowdown in economic growth experienced by most industrial countries since the early 1970s, The debt crisis, while resulting from the conjunction of various developments in the late 1970s and early 1980s, can be seen broadly as the result of a number of developing countries attempting to maintain high rates of growth in a slowly growing, and therefore increasingly competitive, world economy. The excessive debt burdens that accumulated became themselves a further impediment to growth in the indebted countries, and to some extent in the entire world economy. At the same time, slow growth has extended and deepened the debt crisis by weakening the ability of indebted countries to meet their debt service obligations and thereby has postponed a return of confidence on the part of both domestic and foreign investors.

Since 1982, the international debt situation has been a chief focus of the International Monetary Fund’s World Economic Outlook, as well as of the general economic surveys published by other institutions and of numerous books and articles by academic economists. Out of this bewildering mass of data and analyses, one central truth has clearly emerged: the world economy has been facing not only a “debt crisis” but also a “growth crisis,” and that these crises are closely interrelated. The growth crisis emerged initially as the result of the slowdown in economic growth experienced by most industrial countries since the early 1970s, The debt crisis, while resulting from the conjunction of various developments in the late 1970s and early 1980s, can be seen broadly as the result of a number of developing countries attempting to maintain high rates of growth in a slowly growing, and therefore increasingly competitive, world economy. The excessive debt burdens that accumulated became themselves a further impediment to growth in the indebted countries, and to some extent in the entire world economy. At the same time, slow growth has extended and deepened the debt crisis by weakening the ability of indebted countries to meet their debt service obligations and thereby has postponed a return of confidence on the part of both domestic and foreign investors.

The medium-term outlook crucially depends, therefore, on the success with which the governments of industrial and developing countries alike implement policies to promote growth. Growth in the industrial countries is the major stimulus to the expansion of world trade, which in turn is a necessary condition for a satisfactory growth performance in the developing countries. But strong, effective economic management in the indebted countries is also a necessary condition, because the wasteful use of foreign and domestic savings, which itself was a major original cause of the debt crisis, will only weaken incentives for inflows of foreign capital, as well as the repatriation of residents’ holdings abroad. Moreover, merely to respond to foreign demand without an adequate expansion of domestic productive capacity will inevitably lead to a recurrence of pressures on the price level and the balance of payments. These points, while true for all developing countries, are especially pertinent to the heavily indebted and inflation-prone countries of the Latin American region.

This paper, which is based closely on recent work of the Fund staff,1 is divided into two parts. The first part deals with the slowdown of growth in industrial countries, giving a sketch of recent developments, followed by a summary of the medium-term outlook and major policy issues. The discussion will also touch on aspects of policies in those countries that are relevant to the economic environment faced by the indebted developing countries. The second part of the paper will concentrate on the latter countries themselves, first discussing the relative roles of world economic environment and domestic economic management in the evolution of the debt crisis and then reviewing the medium-term prospects, especially for those developing countries with a heavy external debt burden, and the policy choices faced by those countries.

Slow Growth in Industrial Countries

Recent Developments

The deep recession from which the world economy is still recovering was superimposed on a longer-term slowdown in economic growth that dates from the early 1970s. The compound average growth rate of real gross national product (GNP) in industrial countries was about 4½ percent from 1963 to 1973 and just under 2½ percent from 1973 to 1985. The sources of this slowdown are complex and not completely understood, and an analysis of them would be beyond the scope of this paper. It is fairly clear, however, that the slow economic growth was associated with a slower rate of growth of productivity per worker (rather than, for example, a slower growth rate of the labor force), and this in turn was to some extent associated with a slowdown in the pace of capital-deepening. There are indications, however, that other causes—not all of them easily measured—were involved. For example, the rise in energy costs is generally thought to have had a negative impact on worker productivity; other hypothesized factors include the completion of the process of “catching up” in Europe and Japan to technological innovations First introduced in the United States and the growing relative size of the service sector (with its slower measured increase in productivity).2

Superimposed on these long-term trends was the recession of the early 1980s, which had an especially severe impact on developing countries because of the unusual conjunction of high interest rates and (after 1982) limited availability of external finance. The subsequent economic recovery since 1983 has also had unusual features, such as a declining rate of inflation and falling prices of primary commodities. While the recovery of demand and lower nominal interest rates have benefited the indebted developing countries, these benefits have been more or less offset by the sluggish prices in commodity markets and the fact that real interest rates are still high. As the recovery proceeded in 1983–84, it was believed by many observers that its unusual features would be of a sort to ensure continued sustained growth for the remainder of the decade, since low inflation and nominal interest rates, supported by expected fiscal adjustments in the United States, could be expected to stimulate a resurgence of private investment, construction, and household consumption.

Against this background, economic developments in 1985 and in the first half of 1986 were disappointing in a number of respects. Expansion was less than expected in the industrial world, the volume of world trade increased only modestly, and primary commodity prices weakened. As a result, economic growth in the developing countries, which had rebounded in 1984, slowed, and their real export earnings stagnated, which in turn worsened the outlook for the restoration of general creditworthiness, impeded progress in reduction of the relative size of the debt burden, and made it more difficult for many countries to resume a satisfactory growth performance.

Despite these developments, it is the assessment of the Fund staff that economic performance of the industrial countries, and therefore of the world economy as a whole, will tend to improve in the latter part of 1986 and in 1987, since a significant part of the expected benefits from lower interest rates and energy prices has yet to be felt in final demand in industrial countries. Nevertheless, significant uncertainties remain with respect to the impact of major changes taking place in the world economy, including not only the reductions in interest rates and energy prices already mentioned but also the large shift in the pattern of exchange rates and the planned improvement in the U.S. fiscal position. On balance, therefore, the most likely outcome would appear to be a continuation in 1986 and 1987 of the approximately 3 percent growth of GNP achieved for the industrial countries in 1985. This outcome, however, assumes the implementation of the policy intentions of major countries, in particular a substantial cut in the U.S. fiscal deficit that has been the declared intention of both the executive and legislative branches of that country’s government, together with continuation of the somewhat greater monetary accommodation recently in evidence in the United States and some other countries, as well as the supply-side policies discussed below.

Medium-Term Outlook

To assess the correct policies for dealing with the continuing debt crisis of Latin American countries, it is necessary to form a judgment as to the likely medium-term consequences of alternative policies. The medium-term scenario prepared by the Fund staff represents an attempt to come up with such a judgment. The scenario should thus not be interpreted as a forecast of medium-term developments but rather as a set of quantified assumptions aimed at assessing the implications of current trends and analyzing the constraints facing developing countries.

The starting point of this medium-term scenario is to focus on developments in the industrial countries and to treat these developments, for the sake of simplicity, as exogenous to those in the developing countries—that is, it is assumed that industrial countries are essentially unaffected by economic trends in the developing countries. This is admittedly unrealistic, and indeed it is clear that the depression of economic activity in many capital importing countries, including some of the largest ones, has had a significant dampening effect on the industrial economies. Nonetheless, since the influence of economic trends in the industrial countries on the economies of the developing countries is many times more powerful than the influence in the reverse direction, it seems broadly reasonable, and a great deal simpler, to proceed with first constructing a global economic “environment” depending on developments within the industrial countries, and then analyze the impact of this environment on the developing countries.

With regard to the industrial countries, the staff has estimated the growth of productive potential in line with the growth of labor, capital, and productivity in recent years, and it is assumed that output over the medium term (1988–91) will grow at approximately its estimated potential rate in the United States and Japan and slightly faster than potential in most of the other major industrial countries. These assumptions result in an average economic growth rate of 3 percent for all industrial countries throughout this period. Underlying this scenario is the assumption that the governments of European countries will succeed in alleviating some of the structural rigidities that have led to high unemployment rates through implementation of policies discussed in the next subsection.

The Fund staff has assumed that monetary growth will be such as to stabilize inflation in 1988–91 at close to the rates prevailing in 1987. There can be expected to be, in line with this development, a stabilizing of the terms of trade for primary commodities, whose prices after 1986 can be expected to rise in line with, or even slightly faster than, those of manufactures. An improvement in the U.S. current account, and some deterioration in the current accounts of the Federal Republic of Germany and Japan, is projected over the medium term in this scenario, resulting in part from the very sizable exchange rate movements that have occurred over the past year and a half, and in part from the expected improvements in the U.S. fiscal position. Over the medium term, also, the current account deficits of the major industrial countries as a group will tend to grow, mainly because the initial improvements arising from the sharp drop in oil prices will gradually be offset as the volume of oil imports rises in response to lower prices and as the oil exporting countries cut back on their imports. Another important influence on the underlying payments positions of industrial countries is the further accumulation of indebtedness by the United States. The cost of servicing this debt will become a growing element in the U.S. payments position and a reason for the United States to continue to experience a sizable, if smaller, current account deficit, despite recent dollar depreciation and the expected fiscal adjustment.

Policy Issues

From a Latin American standpoint, the principal interest in policies in industrial countries is with regard to what measures might be taken to strengthen their economic growth performance. The fact that mildly optimistic assumptions, such as those employed in the Fund’s medium-term scenario, nevertheless produce a rate of growth substantially below that enjoyed in the 1960s and early 1970s is itself a matter for concern. The concern stems not only from the direct linkages between growth of GNP in industrial countries and the demand for exports from developing countries but also from the well-established fact that low growth and high unemployment in industrial countries has long been associated with protectionist trade and agricultural policies. In this connection, the scenario envisages only modest reductions in unemployment in most European countries over the next Five years. While the situation in Japan and the United States is assumed to be more favorable in this respect, a greater openness of markets in these countries is impeded by long-entrenched policies favoring agriculture and certain problem industries.

As stated earlier, the reasons for the long-term slowdown of growth in the industrial countries since the early 1970s is still in large part a matter for conjecture. For that reason, while there is no lack of proposals for stimulating growth, it would also be fair to say that there is no clear consensus in this regard. In most industrial countries, the policy stance has for some years been based on the notion that improved growth performance requires an environment of financial stability and increased flexibility in the functioning of markets. In line with this underlying concept, governments have sought to reduce the share of resources absorbed by the public sector, to bring down inflation and inflationary expectations through deceleration of monetary growth rates, and to reduce structural rigidities in the operation of markets.

One of the major uncertainties in the world economic environment is whether the impact of reducing fiscal deficits, which in the short run may be deflationary, can be offset by incentives to promote an upsurge of private investment activity and private consumption. The disappointingly weak level of economic activity in the first half of 1986 has given special urgency to this question. Nonetheless, the Fund staff has not concluded that there is a case for changing the present strategy of fiscal policy. First, it seems too early to conclude that the industrial economies have encountered a cyclical downswing. Second, there seem to have been lags in the positive response that might be expected both to lower oil prices (on the part of oil importing sectors and countries) and to lower interest rates; this positive response, however, could be negated if the United States (in particular) fails to assure market participants that its fiscal imbalance is being brought under control.

Fiscal policy is, however, not the whole story, and it is not the same story in all countries. Countries such as the Federal Republic of Germany and Japan, where a strong Fiscal position has already been achieved, are in (or may soon be in) a position to stimulate demand, either through tax reduction or, as in Japan, through increases in public expenditure. The choices here are based on factors special to each country: for instance, on public judgments as to the current adequacy of the social infrastructure. In these countries, but especially in countries that must implement further fiscal retrenchment, other policies are needed to help ensure that the desired “crowding-in” of private sources of expenditure actually occurs. Continuation of a flexible approach to monetary policy, to permit the needed decline in nominal interest rates in line with the lower rate of inflation, is an important element of the strategy. Another concerns the structure of government revenues and expenditure. The tax reform measures passed by the U.S. Congress are one example of measures to induce a greater supply of effort by both businesses and individuals, as well as to improve savings. Another area for possible improvement is in the allocation of government expenditure: clearly, some types of expenditure help more to increase productivity in the economy than do others, although choices here are complicated by the presence of other legitimate objectives of public sector activities.

While there is considerable public debate in industrial countries about the optimum reduction in public spending and the desirability of privatizing certain activities, there is a degree of consensus that improvement of market processes is necessary to improve economic performance. One area where rigidities have long been prominent is labor markets. While attempting to preserve social goals that continue to be valid, it also needs to be recognized that the price of factors of production must be flexible in the face of changes in supply and demand. Such flexibility would limit losses of employment in declining industries or during general economic downturns. Flexibility would be assisted by provision of facilities for retraining and relocating displaced workers. In developing modalities for making wages (and perhaps also hours) more flexible, one has the impression that the industrial world is presently only at the beginning of a period of experimentation. It is a positive sign that in some countries, at least, labor unions have accepted the need for new ideas in this area.

Although the imperfections of labor markets are perhaps the best publicized of structural problems in industrial countries, there are other rigidities whose alleviation or elimination would improve economic performance. One area in which action has been taken in several countries, notably in the United States and Japan, is that of Financial market deregulation. Other areas include the curtailment of subsidies used to maintain uneconomic activities, deregulation when the cost of regulation clearly outweighs benefits, antimonopoly legislation, the sale of publicly owned enterprises, when the latter have not been meeting the test of domestic and foreign competition, and, as mentioned earlier, tax reforms.

It may be wondered why, in a paper for a conference devoted to Latin American problems, so much space should be given to policies in industrial countries. The justification is not only that adequate growth in industrial countries is a sine qua non for resolving both the debt crisis and the growth crisis in developing countries. Also, the solution of the structural problems just discussed is a necessary condition for carrying out the large reallocations of resources in industrial countries that would eventually be involved if their markets were to be opened up to both agricultural commodities and manufactured goods from Latin America and other developing regions.

In addition, it may be noted that such structural problems are also relevant to analyzing the economies in a number of Latin American countries, especially the more urbanized and industrialized ones. Despite the convenient and politically sanctioned division of the world into “industrial” and “developing” countries, it is clear that differences among developing countries—that is, between “middle-income” and “low-income” countries—or between the advanced and the backward regions within the same country, can be much greater than those between the more industrialized developing countries and the less wealthy industrial countries. Just as many of the economic institutions in developing countries have been modeled on those of industrial countries, there is also considerable scope for learning from the efforts of industrial countries to remedy previous mistakes in policies, at a time when, as will be discussed in more detail below, many developing countries must themselves undertake substantial policy reforms.

The Debt Crisis and Its Consequences for Developing Countries

Origins of Debt Crisis

There is a long historical precedent for countries in the early and middle stages of their development to engage in international borrowing in order to raise their rates of economic growth. However, failure to control adequately the growth, structure, and terms of external borrowing can lead to balance of payments difficulties and ultimately set back the pace of economic development. Thus, while all developing countries were affected by the various shocks to the global economy that occurred in the late 1970s and early 1980s, many countries were able to avoid serious liquidity problems and large setbacks to their growth process, while many others were hit by the crisis, with whose features we are all by now familiar. Perhaps a useful way of briefly sketching the profile of the debt crisis is to indicate the differences between those countries that experienced debt-servicing problems—defined for this purpose as those which incurred external payments arrears during 1983–84 or which rescheduled their debt during the period from end-1982 to mid-1985—and countries that avoided such problems.3

It is well known that a protracted tendency for external indebtedness to grow more rapidly than GDP leads to a solvency problem, namely, an inability to service debt out of current national income; that a growing ratio of debt to exports, while sustainable in some circumstances for specified periods, will eventually lead to a liquidity problem, namely, the inability to generate sufficient foreign exchange to pay for both scheduled debt service and essential imports; and that a persistently negative difference between the rate of growth of exports and the average interest rate on debt implies added debt-servicing difficulties. Such difficulties may also be exacerbated by a rising proportion of debt at commercial terms, a fall in the average maturity of the debt, an increase in the share of total debt at variable interest rates (during periods when interest rates in world financial markets are rising), and a rise in the share of short-term debt in the total.

Table 1 shows that a number of these danger signs were strongly in evidence for the vulnerable groups, namely the broad group of countries with recent debt-servicing problems and the group of “Western Hemisphere” countries as defined in the World Economic Outlook;4 the latter group will also be referred to as “Latin American countries.” For those countries, the emergence of danger signs was even more striking than for the broader group of debt-problem countries. For countries that did not encounter debt-servicing problems, however, the four indicators shown in Table 1 were consistently at far lower initial levels, and as a consequence the rise in debt burden (shown as debt and debt service as ratios of exports) was less rapid.

Table 1.

Capital Importing Developing Countries: Selected Indicators of External Debt Developments, 1973–85

Period averages; in percent

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What lay behind these divergent trends was a variety of factors, of differing importance from country to country. One prominent difference between the groups of countries with and without debt-servicing problems was the fact that for the former group there was a sharp fall in gross saving as a proportion of gross domestic product (GDP) between 1977 and 1982, so that net foreign borrowing seems to have been used largely to prevent an equally sharp fall in investment (which did decline somewhat nevertheless). For the countries that avoided debt problems, gross saving actually increased slightly between 1977 and 1982, reflecting in part active adjustment policies undertaken at the onset of the second round of petroleum price increases. It is also significant that, for the debt-problem countries, adjustment since 1982 has entailed a further substantial drop in the investment ratio, while for the other group, which has also reduced its current account deficit, the investment ratio fell only slightly. (The relevant data, presented in Table 2, must be regarded in light of the caveat that saving and investment estimates in many developing countries are subject to a wide range of possible error.) While GDP in the groups of countries with and without debt-servicing problems grew at roughly comparable compound annual rates in 1973–80 (about 5 percent and 5¾ percent, respectively), their growth performance in 1982–85 diverged substantially (0.7 percent and 5.7 percent, respectively). This divergence was related in large part to the amount of investment undertaken, but also to the fact that the countries without debt-servicing problems tended to show significantly lower incremental capital-output ratios than the debt-problem group.

Table 2.

Capital Importing Developing Countries: Gross Savings and Capital Formation, 1973–86

In percent of GDP

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Note: Each figure represents the median value for the indicated group of countries.

Another important factor contributing to the accumulation of external debt has been capital flight. For capital importing countries as a whole, external financing requirements were increased by about two thirds during the late 1970s and early 1980s by outflows of resident capital. For countries in the Western Hemisphere, foreign borrowing needs were almost doubled in this manner, unlike in some regions, such as Asia and the Middle East, where capital outflows represented in large part the prudential accumulation of official reserves and the extension of export-promoting trade credits.

A further factor in the development of debt-servicing problems for some of the capital importing countries was the extent to which borrowed funds were used to increase the economy’s capacity to generate foreign exchange earnings. For countries that avoided debt-servicing problems, export volumes grew by a compound average rate of 4¾ percent between 1973 and 1982, while for debt-problem countries the growth rate was less than ¾ of 1 percent. While this divergent export performance reflected in part different export compositions—which in turn partly resulted from different resource bases and overall levels of economic development—it was to a considerable extent also due to a policy stance favoring the maintenance of international competitiveness and productivity improvements in countries with better export performance. Indeed, the export diversification that often accompanied stronger export growth was typically the result of a sustained policy strategy.

While it would be an oversimplification to say that domestic policies were the main cause of the deteriorating external position of countries with debt-servicing problems, or that policies of other countries were beyond criticism, there does seem to have been a tendency to greater policy weakness in the former group. In particular, in many of these countries, policies were either initiated or continued during the 1970s and early 1980s that included an expansionary fiscal and monetary stance, accompanied by a set of pricing, interest rate, and exchange rate policies, as well as trade and exchange restrictions, that tended to reduce domestic savings and the efficiency of investment, encourage capital flight, and discourage the growth and diversification of exports. By contrast, many of the countries that avoided serious debt problems pursued policies that were at least somewhat more successful at encouraging the domestic mobilization of savings, the efficient use of investable resources, and export growth and diversification. Weaknesses in demand-management and supply-side policies in the debt-problem countries were at times also accompanied by short-comings in external debt management. For instance, as the need for external finance increased, the greater tended to be the relative amount of reliance on commercial and short-term borrowing; and the inadequate monitoring of external debt prevailing in a number of countries enhanced the danger that the debt and debt service would grow to unsustainable magnitudes before the authorities had the opportunity to perceive the situation and put the necessary adjustment measures in place.

The emphasis in this discussion has thus far been placed on the policies carried out by capital importing countries as a cause of external debt difficulties, rather than the more commonly stressed exogenous developments in the world economy that had an impact on these countries. This has been done partly to right the balance of prevailing views, but also because the undeniable effects of exogenous developments were felt alike by countries with and without debt problems and were superimposed on trends of debt accumulation and export performance that had already become evident over the preceding decade.

The only factor that has clearly hurt countries in widely differing degrees has been the movement of primary commodity prices. First, the series of oil price increases in 1979–80 clearly set back oil importing countries. Nevertheless, some oil exporters—notably, Mexico, Nigeria, and Venezuela—experienced serious debt-servicing problems by the early 1980s because of expansionary spending programs that were financed by rapid increases in the level of outstanding foreign borrowing and that included domestic investments, the timing of whose prospective returns was mismatched with the schedule of amortization payments on the corresponding financing. The balance was tipped for these countries by the weakening of oil prices, beginning in 1982. For countries exporting non-oil primary commodities, the combination of weak prices and lower export volumes resulting from the 1980–82 recession led to falls in the purchasing power of exports, and the continued weakness of those prices since 1982 has made it difficult for those countries with a large overhang of external debt to recoup their external position.

The sharp increase in nominal interest rates in industrial countries in 1979–80 fed through to interest payments on external debt especially quickly for Latin American countries because of the large proportion of their debts that was at variable interest rates. Since the increase in nominal interest rates occurred just before the U.S. dollar price of internationally traded goods began to fall, real interest rates rose sharply in 1980, and between 1978 and 1984 the ratio of interest payments to exports more than doubled for countries with debt-servicing problems.

Similarly, the strong appreciation of the U.S. dollar over the period 1981–84 had the effect of depressing the dollar prices of internationally traded goods without a corresponding effect on the U.S. dollar magnitude of external debt (about 80 percent of which is estimated to have been denominated in dollars). Thus, for these countries, about two fifths of the rise in debt ratios between 1979 and 1983 is estimated to have resulted from the U.S. dollar appreciation.

Recent Developments in Debt Crisis

Since the beginning of the debt crisis, the growth of total debt has rapidly decelerated in U.S. dollar terms, although continuing to edge upward as a percentage of exports of goods and services. For capital importing countries as a whole, debt in nominal terms has grown from $761 billion at the end of 1982 to $914 billion (an increase of 20 percent overall) at the end 1985; another $50 billion increase is expected during 1986. For the Western Hemisphere, the increase during this period was from $333 billion to $369 billion, an increase of only 11 percent, with $382 billion projected for the end of 1986. Because of the weakness in commodity prices during this period, even these relatively modest increases in the stock of debt in nominal terms translate into increases in the ratios of debt to exports: from 151 percent in 1982 to 180 in 1986 for all capital importing countries, and from 273 percent to 332 percent in the Western Hemisphere. Nevertheless, debt service ratios improved substantially for countries with debt-servicing problems, partly because of the fall in interest rates but in considerable degree also because of large-scale debt restructurings carried out by both official and private creditors. In the April 1986 World Economic Outlook the Fund staff estimated that market borrowers rescheduled over $80 billion of debt service due during 1982–85, and new or prospective arrangements in 1986–87 would defer another $52 billion. One notable aspect of these arrangements was that the proportion of short-term debt in the total was greatly reduced.

The improvements in the debt situation have been brought about in part through strenuous adjustment efforts, which have brought current account deficits down substantially for virtually all categories of developing countries. For Western Hemisphere countries, deficits declined from –33.4 percent of exports in 1982 to –3.4 percent in 1985. Larger current account deficits are projected for 1986—for capital importing countries as a whole and for Western Hemisphere countries among them, mainly as a result of the decline in primary product prices, especially the price of petroleum.

The weakness of commodity prices throughout the period of adjustment for countries with debt problems has meant that much of the adjustment has had to come about through a compression of imports. The volume of these countries’ imports fell by about 15 percent in each of the years 1982 and 1983. From 1983 to 1986, imports are projected to have risen by only 1 to 1½ percent. In Western Hemisphere countries, the volume of imports was cut by a cumulative 36 percent in 1981–83, with a recovery of about 5 percent from 1983 to 1986. The growth in real GDP of these countries, however, was a great deal stronger than might be adduced by supposing a light link between imports and output. In the Western Hemisphere, for example, there were falls of 1 percent and 3 percent in output in 1982 and 1983, respectively, but increases of 3 percent and 3¾ percent in 1984 and 1985, despite a level of imports that remained far lower than in the years immediately preceding 1982. The apparent reduction in import-dependence of growth during this period may be due to a number of factors, such as the fall in investment ratios (investment expenditure probably tends to be more import-intensive than other types of expenditure) and in aggregate demand (leading to a reduction in consumer goods imports); undoubtedly another contributing factor has been the depreciation in real effective exchange rates in most countries carrying out major adjustments, which would have had the effect of raising import prices relative to prices of domestic goods and therefore of encouraging both direct import substitution, as well as a switch from traded to nontraded goods in the consumption expenditure as a whole.

Two views are possible of the recent performance of the debt-problem countries in general and Latin American countries in particular. An optimistic view would stress the fact that, despite an extremely unfavorable external economic environment, declines in the levels of economic activity in these countries were limited to relatively small magnitudes, thanks in part to the efforts of the Fund and private creditors to provide debt relief and some new financing, and in part to strong adjustment efforts by the countries themselves, which, inter alia, tended to maintain the volume of exports. As a result of all these efforts, and the recent decline in interest rates, debt service ratios have fallen significantly, and for a number of countries that experienced debt problems the situation has become more manageable than it appeared a few years ago. Indeed, for a number of these countries, an acceleration in the momentum of” economic growth appears to be underway.

A more pessimistic view would stress the fact that per capita income for developing countries as a whole has been virtually stagnant since 1979, and for some important groups of countries—for instance, in Africa and in the Western Hemisphere—has actually fallen; for these groups, even the most optimistic projections would not foresee reattainment of the per capita income levels of the late 1970s until 1990. Furthermore, the poor performance of commodity prices since 1981 has offset efforts to reduce the debt-export ratio. For this and other reasons, many countries face years of further adjustment efforts before being assured the commercial external financing that they consider necessary for resumption of their growth efforts. Until that time, they face as well a depressed domestic economic outlook, which has a discouraging effect on private investment.

Both these views capture key elements in the outlook for Latin American, as well as for other, indebted countries. They have been taken into account in the medium-term scenario for capital importing developing countries prepared by the Fund staff, a description of which now follows.

Medium-Term Outlook

The baseline medium-term scenario just referred to is grounded in the assumptions regarding economic developments in the industrial countries which were described above (pp. 29–30). The key assumptions and results of the scenario are summarized in Table 3.5 Basically, the picture given by these assumptions is one of sustained growth in those countries at rates that are relatively modest compared with those attained in the 1960s and early 1970s. These growth rates would be accompanied by equally modest rates of inflation. The real depreciation of the U.S. dollar that took place in 1985 and 1986 would form the basis for the structure of rates assumed to be in effect for the remainder of the decade. The oil price decreases occurring early in 1986 would not be reversed, but oil prices would rise in tandem with the prices of other goods in world trade after 1987; for non-oil primary commodities, the deterioration in prices that occurred in 1982–86 would be partially offset by these prices rising somewhat more rapidly than oil and manufactures prices over the period 1988–91.

Table 3.

Summary Results of Baseline Medium-Term Scenario, 1977–91

In percent

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Note: Based on results published in International Monetary Fund, World Economic Outlook: A Survey by the Staff of the International Monetary Fund (Washington, April 1986).

Compound annual rates of change.

London interbank offered rate on six-month U.S. dollar deposits, deflated by the U.S. GNP deflator.

In U.S. dollars.

Includes trade financing.

Underlying this scenario, also, is an important set of assumptions concerning the availability of external Financing for developing countries as a whole. This assumption constitutes a kind of constraint for the entire scenario exercise, as it specifies maximum flows of financing available to all developing countries but does not specify projections for individual countries or groups of countries; these were carried out by the economists who prepared the projections for individual countries upon which the first round of the scenario exercise was based. Thus, only if the sum of individual assumptions exceeds the assumption of total financing for all capital importing developing countries is any adjustment made to the projections aggregated from individual country estimates. For the group of capital importing developing countries as a whole, then, it is assumed that flows of official development assistance will remain approximately constant in real terms and that foreign direct investment will rise roughly in step with real GDP in host countries, while trade credits rise pari passu with imports. Private lending (in terms of U.S. dollars) is assumed to rise at an annual average rate of about 2 percent over the period 1988–91, reflecting continued caution on the part of commercial banks with regard to non-trade-related private lending. Nevertheless, the sum of the financing assumptions imply continued growth of external indebtedness in real terms.

A final set of assumptions underlying the medium-term scenario relates to the policies followed by the capital importing countries themselves. Fund desk economists were asked to describe, and to build their baseline projections on, the policies most likely to be pursued by each country’s authorities over the scenario period. The resulting projections reflect the fact that external circumstances will be continuing to compel the authorities in many countries to follow policies directed toward reducing internal and external imbalances. These policies account in large part for specific features of the scenario outcome, which is summarized in Table 3 (which also shows recent developments and the short-term outlook). For instance, the declining current account balances of the capital importing countries, and especially those with debt-servicing problems, are policy related, as is the fact that import volumes, as already pointed out, have grown less rapidly than output during the period of adjustment (1982–85) and are projected to grow at approximately the same rate as output over the medium term, in sharp contrast to the period before 1982, when imports grew substantially more rapidly than GDP. These developments stem in considerable part from strong demand-management and exchange rate policies, although also to some extent from imposition of trade and exchange restrictions.

Notwithstanding the generally weak growth performance of the countries with debt-servicing problems since 1982, their growth is expected to pick up substantially after 1986. This is due to two principal factors. First, the fall in commodity prices has apparently bottomed out; the terms of trade for non-oil commodities should undergoaslow improvement from 1988 to 1991, while the price of oil is also likely to keep pace, at the very least, with prices of other traded goods. (With regard to oil prices, the staff estimate is probably on the conservative side, since the repercussions of the recent fall in petroleum prices on world demand and supply have not had time to work themselves through). Assuming that there is no lightening of protectionist restrictions in either industrial or developing economies, the growth of export revenues should both stimulate and facilitate the achievement of higher rates of growth of demand and investment, supported by higher rates of growth of imports. Second, the short-term deflationary effects of the adjustment policies that have been carried out over the past four years have dominated longer-term benefits for the allocation of resources, which can be expected to show their full impact over the next several years. Admittedly, however, the results of the scenario may also depend to some extent on a shift of emphasis in policies in the debt-problem countries, which is discussed in the succeeding subsection.

The steady growth of exports, combined with import growth that is only slightly faster than that of output, will enable these countries to maintain current account balances (relative to exports of goods and services) that remain low by historical standards, although the sharp rise in current account deficits of countries exporting petroleum and non-oil primary commodities has raised substantially the overall current account ratios of capital importing countries (and subgroups, like the Western Hemisphere countries) from the ratios achieved in 1984–85, Thus, the accumulation of external debt will proceed at a relatively modest pace, while the improved growth of export revenues projected, together with the lower interest rates expected to prevail in world financial markets, will also contribute to a steady reduction in the ratios of debt and debt service to exports of goods and services (see Table 3).

The scenario results for the Western Hemisphere countries, also shown inTable, reveal trends similar to those for the broader groups of capital importing and debt-problem countries; the difference is that for Latin American economies the starting points for debt and debt service are very much higher, and therefore the overall external position much more vulnerable. While the Fund staff considers the projections presented here as a feasible possibility, there is admittedly room for discussion of whether the rates of economic growth projected for the Western Hemisphere countries would in practice be achievable without greater net capital inflows; such inflows, however, if taking the form of financial borrowing at commercial terms, would add to stocks of such debt that are already intolerably high. This issue, as well as related questions, is considered in the following subsection.

Policy Issues

The developments in industrial countries, reviewed above, are the major determinants of the external economic environment facing the developing countries. The conclusion to be drawn from that discussion is that effective, well-coordinated policies among the industrial countries can be expected to result in a sustained rate of economic growth of about 3 percent, which is considerably lower than that attained during the years between the post-World War II recovery and the first oil shock. While it is possible that strong supply-side policies, accompanied by an upsurge of confidence in the private sector, could result in a better growth performance, our limited understanding of the reasons for the decline in growth in the 1970s gives little ground for firmly linking specific policies with an improvement in this regard. Not only does this outlook limit the potential growth of demand for exports of developing countries, it also renders uncertain the progress that is likely to be made in opening up markets in industrial countries and in increasing flows of official concessional assistance. At the same time, continuing limited growth and heavy debt burdens in many of the capital importing countries suggest that future increases in commercial lending and direct foreign investment are unlikely to proceed at a rapid pace, and in any event both the governments of debtor countries and the international financial community will continue to perceive a need to reduce debt ratios, and therefore to maintain relatively low current account ratios.

One must conclude, therefore, that the governments of countries with debt problems must confront the task of achieving satisfactory rates of economic growth—in broader terms, meeting their long-term development objectives—in the face of a relatively unsatisfactory world economic environment. This is not to say that the international community should not seek to press for enlightened policies of national governments that would improve that environment—for instance, more liberal trade policies that would improve long-term growth prospects in both countries where import protection is reduced and those whose exports thereby benefit. Nonetheless, it would be imprudent to base domestic policies of indebted countries on the expectation of dramatic improvements in foreign trade opportunities or in official development assistance in the foreseeable future.

The fundamental question, then, is how to deal with what has earlier been termed the growth crisis without at the same time worsening, or failing to deal effectively with, the debt crisis. Acknowledging that there is ample scope for creditors to restructure outstanding debt and improve terms—and as mentioned earlier, such steps have already been taken in many instances—it must also be said that the unilateral repudiation of debts or limitation of debt-service payments by debtors is as short-sighted as would be the refusal of creditors to contemplate any form of debt relief, because such a unilateral action would increase the reluctance of creditors to extend any new financing in the future. Similarly, it is shortsighted to undertake domestic policies that lead to temporary increases in domestic demand and output at the expense of future improvements in the efficiency of resource allocation, in growth potential, and in international competitiveness.

As usual, the Fund finds itself in the role of having to deliver a message that is not universally popular. The fact that it must play this role is often mistaken for a lack of concern about the immense problems of poverty in many countries, even in those countries in Latin America that can be regarded as semi-industrialized and relatively advanced. The Fund never ceases to call for greater flows of concessional assistance to those countries that are in need of it and can demonstrate that they can use it effectively. But its chief function is to advise members on how to achieve the best possible results on the basis of admittedly unsatisfactory circumstances.

In this context, chief emphasis must be put on improved policies in the debtor countries themselves. In most instances, the scope for improvement is substantial. By the early 1980s, many countries had come to depend, as a matter of routine, on the inflationary financing of government deficits, with the result that inflation—with all its attendant distortions of prices and investment incentives—had become engrained in both the expectations of the private sector and the decision-making machinery of the government. A necessary, if not always sufficient, condition for eliminating such inflation was the reduction of the combined demands of the government and private sector for credit so that aggregate demand would be brought into line with supply, given a real net capital inflow that represented a sustainable increase in external indebtedness. Success in undertaking such initial measures, however, has often been at the expense of the level of economic activity and at the same time has not always been sufficient to reduce inflation to manageable rates. The initial success of the recent policy experiments in Argentina and Brazil suggests that extraordinary measures may be necessary in the face of long-entrenched high inflation, although what is the most effective sequencing of such measures with the conventional instruments of demand management is still an open question, as the rather different approach taken in Bolivia suggests.

More seriously, however, the recent experience in Latin America also suggests that growth is inhibited not just by inflationary distortions but by problems typically called “structural,” a blanket term covering both the way in which resources and investment are allocated and the pattern of incentives faced by producers in both the private and the public sectors. A possible interpretation of developments in recent years is that in a buoyant world economy there was more room for wasteful investment and misallocation of existing resources than during a period of stringency, so that only since 1982 have certain deep-seated problems inhibiting growth in many economies become fully clear. A somewhat different interpretation would stress the fact that many of the structural problems are part and parcel of underdevelopment itself, and getting out of them would require the massive investment in both physical and human infrastructure that is in considerable part excluded by the constraints presently posed by both the fiscal situation and the scarcity of external financing.

Despite these constraints, however, considerable improvements are possible both with regard to the allocation of public expenditure and the operation of markets. Such policies will serve to increase domestic saving and to stimulate more efficient investment decisions, in part by facing investors with the true economic cost of capital and of foreign exchange. Improvements on the fiscal side are covered thoroughly in the paper presented to this seminar by Vito Tanzi and therefore require no further treatment here. In addition, there exists a wide range of possible actions to promote savings, investment, and efficient choices within the private sector. Such policies include the correction of misaligned exchange rates and interest rates; removing other price distortions created by government action; and freeing individual productive units, whether private or state-owned, from inefficient, burdensome, and often inconsistent government controls over their activities; and liberalizing restrictions on foreign trade and payments.

This is not to say, of course, that the government does not itself play an important role in directly fostering productive activities in the private sector. Its role is perhaps even more crucial, in some respects, in developing than in industrial countries, for instance with regard to the provision of “human” infrastructure. It is also necessary at times for the government to sponsor the creation of new private economic institutions, as is sometimes true, for example, with regard to the reform of financial institutions. Agriculture is also an area in which government infrastructural and technical assistance often plays a crucial role, especially when agricultural production is dominated by small-scale producers.

In the types of policies outlined above, as well as those discussed in Mr. Tanzi’s paper, the more efficient operation of market forces can contribute not only to the promotion of exports (especially by maintaining a realistic exchange rate and liberalizing imports) but also to efficient import substitution. An example of this is food production, which is often subject to negative biases through official price controls; and the proper pricing of foreign exchange may also stimulate other types of import-substituting production, for example, of basic consumer goods. There is a danger, however, that unfavorable developments in the world economy, leading to poor export prospects and inadequate external financing for indebted developing economies, will induce some countries to undertake a strategy of import substitution that is based on restrictions and controls rather than on comparative advantage. Such policies are self-defeating, since they tend to undermine export performance and create import-intensive industries, while reducing the scope for long-term economic growth. Moreover, such policies encourage heightened protectionism in other countries, thereby further dampening the growth of world trade.

It goes without saying that a policy strategy of improving growth and maintaining a strong current account performance (because of continued scarcity of external financing) requires strong macroeconomic policies, especially because of the need to mobilize domestic savings and to discourage capital flight, as well as to create a favorable climate for private investment. Fiscal and monetary restraint are required to keep inflation under control and limit the share of saving captured by the government.


The world economic events of the past half-decade have brought about a significantly heightened perception of global economic inter-dependence. The facts, for example, that an economic crisis in large Latin American countries could threaten financial stability in industrial countries, or that a sharp cutback of Latin American imports has a significant impact on North American jobs, represent new insights for the noneconomist. Recent issues of the Fund’s World Economic Outlook have emphasized, to take another example, that creating more dynamic economies in the industrial world is not only an important goal for its own sake but perhaps even more important for its implications for the developing countries. While it would be naive to suppose that these considerations have become dominant ones for governments in industrial countries, the perceptions of these interconnections have become far more widespread, and are far more often mentioned, in public discussions.

This fact, admittedly, is at this point cold comfort for the governments and people of Latin America, faced with difficult decisions and little prospective relief from recent cutbacks in living standards. In this setting, one hopeful sign is the redoubled effort of international institutions, especially the World Bank and other multilateral aid institutions, to expand flows of assistance. The Fund has proceeded on several fronts to give assistance. Indirectly, it is hoped that efforts by industrial countries, assisted by technical inputs from the Fund, to better coordinate macroeconomic policies, will nurture sustained growth of the world economy. In addition, the Fund continues its role of policy advisor and catalyst for external financing for countries with debt problems, and it has repeatedly urged all parties concerned to increase private and official financial flows to countries that can use them effectively. In particular, there is a great need for additional resources to be channeled to low-income countries in forms that do not lead to unsustainable increases in debt burdens. The Fund has also repeatedly called for efforts to liberalize world trade, which would be of special importance for Latin American countries, many of whom have substantial industrial sectors and have a chance to increase their exports of manufactures. This would require a combination of domestic reforms in these countries, together with new trade agreements under the General Agreement on Tariffs and Trade and a rolling back of trade restrictions introduced during the past several years. There is also scope for expansion of certain types of agricultural exports, whose volume is presently limited by protectionist agricultural policies in a number of industrial countries.


In particular, International Monetary Fund, World Economic Outlook: A Survey by the Staff of the International Monetary Fund (Washington, April 1986).


For a discussion of these factors, see International Monetary Fund, World Economic Outlook (cited in footnote 1), pp. 163–71.


This discussion is based on the Fund’s April 1986 World Economic Outlook (cited in footnote 1), Chapter V. For definitions of the two groups of capital importing countries, see the Statistical Appendix of that publication, p. 174.


In the World Economic Outlook (see footnote 1), the Western Hemisphere group comprises all countries in the hemisphere except the United States and Canada.


The figures in Table 3 are based in general on those that appeared in the April 1986 World Economic Outlook (see footnote 1) but were updated in September.


Carlos Bazdresch P.

Mr. Lanyi’s paper is undoubtedly a work of great interest. It coherently combines a good deal of the thinking and the research efforts of the International Monetary Fund staff. It is a paper that we can all benefit from reading, both because of Lanyi’s efforts to form a coherent whole and because of its informed speculation as to the future.

I agree with Lanyi that current data suggest that the medium-term scenario for the industrial countries is that they will on average grow at a relatively slow annual rate of about 3 percent. This is neither the time nor the place to discuss this prediction. I will only say that the same prediction is being made in places very different from the Fund, such as ECLA, although there the most widely accepted prediction is of an even lower growth rate. This fact undoubtedly adds some plausibility to Lanyi’s forecast. It is not an optimistic prediction to give us cause for celebration, but neither is it a pessimistic forecast foreshadowing some disaster. It is, I would say, rather a melancholic prediction, heaped with nostalgia for the good old postwar days.

I also concur with Lanyi that it is not easy to foresee from this scenario any sizable increase in official funds to finance growth in the developing countries. It is equally difficult to foresee the industrial countries reducing their protectionism, not even—or perhaps even less so—their agricultural protectionism. From this, Lanyi’s assertion that “… it would be imprudent to base… policies of indebted countries on the expectation of dramatic improvements in foreign trade opportunities or in official development assistance in the foreseeable future” would appear to be valid. What is more, in terms of the scenario Lanyi describes, this statement is optimistic.

As Lanyi indicates, we deduce from this that the countries that are currently experiencing difficulties because of the size of their external debt have to make some changes—which we are now supposed to call “structural”—to increase their savings ratio, the productivity of their economies, and their export capacity as fast as possible. Once again—this time, it would seem, definitive—the death of the import substitution “model” has been announced.

Despite all these points of agreement with Lanyi’s paper and many others that I could mention, I note that it lacks any reference to a number of important issues.

In the first place it should be noted that, although the scenario described by Lanyi is currently the most widely accepted, it assumes that the confrontation between the two international blocks does not generate any inflationary pressures or large-scale violence. Let us hope this is so. But like Sombart, we must remember that expenditure on weaponry has always been a driving force behind economic growth, so that if the confrontation does not abate, the situation, unfortunately, could become quite different. No less strange is the prediction of slow growth in the capitalist world at a point in time when technological change not only seems to be accelerating but has taken root in so many different places at once. This dissemination, no longer just of new technology but of the ability to copy technology from other places and generate new technology autonomously, would encourage a follower of Schumpeter to forecast that economic growth in the capitalist world will accelerate rather than slow down. Perhaps Lanyi believes that this is a “metaphysical” view. He is probably right.

A second point concerns the tendency noted by Lanyi to protectionism in the developed countries. I do not deny that the evidence so far supports Lanyi’s statement. However, it should be noted that, because of the very fact that there is a crisis, such protectionism will be ever more expensive for the countries that practice it. The point here is that by lowering real wages in the developing countries the competitiveness of their agriculture will very rapidly increase, especially with regard to products with high specific value such as flowers, fruits, vegetables, and so on. The same would apply to already standardized manufactured goods. Consequently, protectionist barriers in the developed world will perhaps have to increase. This may occur, but in that case the high cost of such barriers will become increasingly obvious to consumers as well as to efficient production sectors in the industrial countries. Why does Lanyi believe that these sectors will not act to defend their interests?

A third comment relates to the need of the developing—particularly the overindebted—countries to create export capacity. In my opinion, this need is inescapable. However, like Lewis,1 we must remember that this capacity should not be achieved at any price or by sacrificing import substitution policies too hastily. The problem is that, if all the low-wage developing countries try to export manufactured goods, it is most likely that they will be faced once again with a sharp decline in their terms of trade. Consequently, the correct policy needs to be thought through carefully.

But what is most noteworthy in Lanyi’s paper is the lack of any discussion of what could happen to the Financial system, and, particularly, of what could happen on the external debt front of the Latin American countries. The absence of any such discussion would seem to imply that Lanyi believes that things will continue more or less as now, or at least that whatever changes do occur on this front will not affect the other variables very much. It seems to me, however, that it will be difficult for things to continue the same in the future and, it also seems to me that, although for the world as a whole Latin American debt may not seem to be very important, for our countries—Argentina, Brazil, Peru, and Mexico—what might happen on this front is indeed of great importance.

It is possible, but not probable, that the present answer to the excessive indebtedness of some countries, outstanding among which, of course, is Mexico—based on involuntary commercial bank lending and “continuous” adjustment by the debtor country—will last for much longer. One of the several reasons for this is that practically none of the participants are happy with this solution.

The agreement between Mexico and the Fund drawn up in August 1986 was an appropriate and indeed an imaginative one. It cannot be denied that to reach this solution was an achievement in international cooperation. The Mexican authorities have expressed their appreciation for the support the Fund and the authorities of some of the creditor countries gave them. This support was the key to their reaching such a solution. It is obvious, however, that even with all its good points this agreement offers Mexico no more than the minimum, as it granted barely enough funds to enable Mexico’s economy to grow at a very moderate pace in 1987–88. Mexico, with a labor force that grows by just under one million persons a year, has to boost its growth rate significantly if it does not wish to confront a vast structural crisis a few years down the road. Furthermore, while the above-mentioned negotiations succeeded in providing financing to cover needs in 1987 and perhaps also for 1988, the bare minimum financing for subsequent years was not found. This undoubtedly creates uncertainty in the private sector, which may again translate into pressure on the capital account. Thus, I think it very probable, if there is no substantial recovery in oil prices, that in the future—maybe in 1989—there will have to be another great negotiation process. This means that, despite the amount of financing and the advantages and new concessions that Mexico succeeded in obtaining in the 1986 agreement, by not having insured that the “net” transfer that Mexico will have to support in the next several years is consistent with the maintenance of a reasonable growth rate, the opportunity to achieve a lasting solution was missed.

It seems obvious to me that this agreement did not satisfy the creditor banks either, because they have pointed on many occasions to the undesirability, from their point of view, of increasing their exposure by acquiring more Mexican debt. Nor do I believe that the international financial authorities or those of the creditor countries are very happy to have to make such strenuous efforts to convince many commercial banks to take part in financing the agreement with Mexico.

In these circumstances, who is happy? If few—or none—are, the situation will probably change. What form might this change take?

There is one form this change will not take: the excessively indebted countries, with their inefficient productive infrastructures, will not turn into major exporters overnight thanks to some miraculous structural change, which indeed should not take place too swiftly, as it would then be unlikely to be a lasting one. Thus, for example, while I am quite sure that the Mexican Government will do its level best to comply with its side of the 1986 agreement, I am also sure that time will inevitably be required for these changes to mature—time that Mexico will also need in order to make a lasting recovery in its ability to pay.

Furthermore, I wonder whether in the relatively near future it will be more or less inevitable for the major creditor banks to have to increase the pace at which they are absorbing the loss of capital associated with the liquidity of the Mexican debt. Of course, considerable reserves have already been set up for this purpose, and perhaps there would be some way for this to take place in an orderly fashion. Both the multilateral institutions and the governments of the creditor countries can contribute to this process. As a matter of fact, as we all know, many solutions have been proposed to allow this absorption to take place in an orderly fashion, thus providing a foundation for an increase in the growth rate of the debtor countries.

The fact that this process may be taking place in an orderly fashion could help solve the debt problem, in that there would not be—as there has been until now—a threat of the debtors having to confront a new balance of payments crisis in the immediate future. This was on the point of being achieved in the 1986 Mexican agreement, but the issue was not yet ripe; perhaps it will become so at some time in the future.

These ideas suggest two scenarios different from those put forward by Lanyi:

In the first, the banks would continue to fail to absorb their capital losses and the governments would continue not to help them to do so. What would most probably happen then is that there would be an attempt to continue imposing the solution of involuntary lending and almost continuous stagnation in the creditor countries—especially if the latter do not behave properly. In this case, the creditors’ united front would possibly split, with some banks finding themselves in serious difficulties, while some debtor countries would move ahead and others would declare an official or unofficial moratorium on their debt service.

The second scenario would follow from a decision to help banks absorb capital losses and to help debtor countries agree to a lasting solution to their external debt problem by trying, through adopting some of the many formulas that exist for this purpose, to make the debt service burden compatible with the achievement of a reasonable growth rate. This growth would allow time for the so-called structural change to mature so that the economies that are now excessively indebted could regain their ability to pay.

Hence I conclude that it is likely that the outlook for growth in Latin America will be either more pessimistic or more optimistic than in the scenario Lanyi offers us.

Winston Fritsch

Anthony Lanyi’s paper is divided into two parts. The first analyzes the prospects for growth and the interaction of macroeconomic policies in the North and, consequently, the economic environment for the debtor countries. As was clear from his presentation, the analysis is conveniently divided into the short term, that is, until 1987, and the medium term, until the end of the decade.

The indebted economies are analyzed in the second substantive part of the paper. There is a brief overview of the situation since the 1982 crisis, and the outlook for the indebted economies is discussed in the scenarios outlined during the previous session.

I will organize my comments along the same lines as the paper itself. Thus, regarding the first part, I will start by commenting on the short-term scenarios. Mr. Lanyi rightly notes that events of 1985–86 are “discouraging”: the sluggishness of the OECD economies and the abrupt worsening of the terms of trade of the indebted countries are factors that explain this. But he is optimistic about the near future, as the Fund, in the estimates on which it bases its forecasts, believes that the industrial economies will recover, as a result of lower interest rates and lower oil prices, and concludes that growth will be maintained at 3 percent, if—he says—the United States budget deficit is brought down and monetary policies remain flexible.

I think these forecasts need further elucidation. In the first place, I think that the main—because it is the surest—factor in the buoyancy of the world economy over the next eighteen months, is the effect of the real exchange rate adjustment of the dollar, and this is not referred to explicitly. The depreciation of the dollar will bring about an improvement of some US$30 billion in the U.S. trade deficit, which should add something like 0.75 percent to the growth rate of the United States.

As to the effects of the lower interest rates and oil prices, there is not the same certainty as there was when the Fund staff made the forecasts published in the World Economic Outlook early in the second quarter of 1986.

There are two effects connected with interest rates: first, I do not much believe in the estimates of the overall effects of monetary and fiscal impulses derived from the linkage models in the context of flexible exchange rates, because their variability is very large. The assertion by the author as to the possibility of an interest rate decline implies an optimistic view of the current flexibility of monetary policy implementation in the North, particularly in Europe and Japan. Interest rates in the main financial markets very probably will not continue to decline in a coordinated fashion. The recent comments by Mr. Pöhl, not to mention Mr. Stoltenberg, are not very encouraging in this respect, and if the Japanese were more explicit in discussing their monetary beliefs, they would be saying the same thing.

As to the effects of the decline in oil prices, it is interesting to note that when the Fund’s World Economic Outlook was drafted there was more optimism about the positive effects of the decline in oil prices on demand in the OECD countries. But now we have seen that the oil collapse had a very perverse effect on the investment rate in the oil industry and other energy sectors as well as on imports by the major oil producers. The net effect on demand in the OECD countries is uncertain.

But as the author notes, the Fund’s optimism is more apparent in its medium-term projections. In these projections, the methodology takes into account almost exclusively supply-side factors: these are mainly estimates of growth in the potential output of the major economies on the basis of forecast growth of productivity and factor endowment. Today’s gigantic demand-management and coordination problems are assumed to have been solved. Thus, for example, it is assumed that money management will stabilize inflation and, more interestingly, that an improvement in the U.S. current account will take place in parallel with a reduction in the U.S. Fiscal deficit. This scenario is clearly an extremely optimistic one. What would guarantee this happening is not discussed by the author. Note, for example, that if only the current account improves in the United States and the public deficit is not reduced, the revival in the level of activity and the consequent reduction of net saving in the private sector will certainly trigger a new interest rate hike, as happened in 1984.

In addition, there are the worrying questions related to the potential instability of international financial asset markets caused by the U.S. debt crisis; that is, by the accelerated growth of U.S. debt. As the United States changed from a net receiver of interest in the order of US$20 billion in 1982 to a payer of almost US$40 billion in the projected trade account for 1987 and the following year, it can be estimated that the U.S. external debt may reach about US$500 billion in 1989 and US$1 trillion in the first half of the 1990s. In this scenario, with a more or less stable exchange rate, if what we know about portfolio behavior is correct, I do not see how we are going to avoid an interest rate hike in dollar assets. This is not touched on in the paper.

And even in this medium-term scenario, looking at it optimistically, I think that with sustained 3 percent growth in the North, as predicted in the paper, the projection regarding the behavior of primary product prices, excluding oil, is a little conservative. I think that if the projections are made on the basis of the price equations derived from Chu and Morrison’s research undertaken in the Fund, we would obtain more optimistic results. I wonder if there are implicit pessimistic hypotheses on the supply side that would explain the low price growth projected.

But allow me to turn now to the second substantive part of the paper, in which the author discusses the effects of these scenarios in the North on the indebted countries. Here I believe that the paper is too much concerned to demonstrate that the crises in the Western Hemisphere countries are to a large extent the fruit of their own policy mistakes, when compared with the performance of that other, “virtuous,” group of developing countries—although these virtues are not exactly dwelt on in the paper. I think this kind of exercise is not very fruitful; by which I mean that there is little sense in separating and comparing a group of “sinful debtors,” heterogeneous and all roughly comparable in size, on the one hand, with another group of “virtuous debtors.” This is because there is a considerable variation in structure between the two groups, the virtuous and the sinful. For example, what sense is there in comparing the performance of a country like the Republic of Korea, which experiences an improvement in its terms of trade when the prices of raw materials collapse, whose export structure responds very positively to real devaluations, and which continues to turn to the banks for voluntary finance, with a country like Bolivia or even Mexico?

This “virtue” is to a large extent a product of the structural characteristics of their economies. Obviously the policies followed in Latin America were not exactly the best in every case, but it would have been more thought-provoking if this section had also discussed the mechanisms by which the shocks and fluctuations in the North are transmitted to the South. In this respect, today’s discussion will only be complete after Professor Dornbusch’s paper is presented this afternoon.

However, to have a proper view of this problem, it would be interesting to have something like a sensitivity analysis to quantify how it is that probable variations of such basic parameters as interest rates or GDP growth in the OECD affect the various groups of debtors in different ways. I think that the paper suffers a little, as do the Fund’s estimates, from not making an appropriate disaggregation among the various groups of indebted countries. For, in fact, there are great differences between the indebted countries in terms of the effects of various world economic scenarios in relation to given variables. For example, Argentina, which has a very high debt/export ratio, is very sensitive to interest rates. Mexico, obviously, is very sensitive to oil price changes, and so on.

In conclusion, I would like to comment on two general points. First, there is a problem which in my view is now central to the future of our economies: the likelihood of more or less coordination of macroeconomic policies in the North and how it relates to the potential stability of the world economy. In this context, I would like to hear the ideas of the members of the Fund staff here today as to what role the Fund can play in promoting greater international economic coordination. I believe that at the most recent summit meeting in Tokyo last May, the Fund was informally given the task of designing objective indicators and surveillance mechanisms to enhance coordination. But nothing seems to have come of it so far.

Second, I would also like to have your comments on a point I think is crucial today for the debt problem. I think it is obvious that what Mr. Lanyi called the “growth crisis”—basically a problem created by the lack of savings to support medium-term growth, given a more or less fixed capital/output ratio, and the fact that there was an abrupt fall in the investment ratios in these economics after 1980—is a problem which, in addition to the effort to increase domestic savings, clearly calls for a reduction in real transfers abroad, and an end to the uncertainty inhibiting the growth of private investment. So I am asking you if you feel that the most likely medium-term scenarios will lead to these two favorable results that will help our countries overcome this savings/investment restriction.


See W. Arthur Lewis, The Evolution of the International Economic Order (Princeton, New Jersey: Princeton University Press, 1978).